By now, you have already seen dozens of articles about the recently-passed “Tax Reform and Jobs Act.” While it has not yet been signed into law, there is a great deal of speculation about the final bill. Specifically, people wonder about how the changes will affect the ownership of real estate.
Every situation is different, and you can’t rely on the on-line calculators that claim to show you how much you’ll save under the tax plan. Taxation is necessarily complex, but this article should give you some guidance about how to arrive at your own conclusions—based on the actual bill, not on some pundit or politician’s speculation about it.
The up-front disclaimer
Your humble author is not a CPA, tax preparer or tax lawyer. While I make every possible effort to be sure what I say is correct, you should not consider any of this to be authoritative tax advice. Rely on your regular tax person for that. If you (or your tax person) find any errors in this article, feel free to reach out to me directly.
Income tax is quite a bit more complex than it may appear from this article; but even though I am intentionally over-simplifying it a bit, you should come away from reading this with a good understanding of how income taxes work—and, more importantly, you should be in a better position to determine what, if any, benefit there is for you in the new tax law. Be patient as we work through the basics.
How taxes work
In order to understand what benefits you may receive from the new tax bill, you should know how our progressive tax system works. “Progressive” means that each portion of your income is taxed at a progressively higher rate. I’ll use a filing status of “married filing jointly” throughout, for simplicity.
The tax on the first $19,050 of income is taxed at 10%. From $19,051 to $77,400, it’s taxed at 15%, and so on. The percentage is called the “marginal tax rate.” It is not your overall tax rate—the percentage of your income that you actually pay.
The table is arranged to simplify your calculation. Here is an example:
Your taxable income is $100,000. That means you are in the 25% bracket—you are above $77,401 but below $156,151. You’ll pay base tax of $10,658 plus 25% of the income above $77,400. That’s $22,600. 25% of that amount is $5,650. Your total tax is $16,308, which is an overall rate of 16.3%.
Deductions, exemptions and credits
You are allowed to reduce your gross income by certain deductions and exemptions to minimize the income tax you owe. Here is where they come into play.
An “exemption” is what used to be called a “dependent.” Each exemption is worth $4,150 (2018 schedule before the tax bill). For a married couple, you’ll get two exemptions, for $8,300, plus one for each dependent child.
“Deductions” are other items you will use to lower your taxable income. If you own a home, you may choose to deduct the mortgage interest you paid, along with property taxes and state income taxes. There is also a “standard deduction” you will use if it’s more than the total of the things you can itemize. It’s $13,000 for a married couple filing their return jointly.
Subtracting exemptions and deductions from your Adjusted Gross Income (AGI) give you taxable income—the number used to calculate how much income tax you owe.
Finally, you may receive tax credits. These reduce your tax liability on a dollar-for-dollar basis. One popular tax credit is the child credit, where families are able to deduct $1,000 for each child in the household 17 years of age or younger. Another is the Mortgage Credit Certificate (MCC), which allows a qualifying first-time buyer to claim a percentage of their mortgage interest (currently 20% in California) as a tax credit.
One simple scenario: A married couple with one child, filing jointly. They earn $100,000 annually and do not have enough deductions to itemize, so they’ll use the standard deduction. Their income tax numbers will look like this:
One more scenario before we look at the changes. Our young family just bought a home, so they have some interest and property tax to deduct. Let’s say they also paid $2,000 in state income taxes. If the total of these items is more than $13,000, they’ll itemize their deductions on Schedule A of their tax return.
They bought their home last year for $530,000. It’s their second home, so they were able to put 20% down. They paid $18,000 mortgage interest and $6,500 property tax. They’ll itemize these, along with the $2,000 state income tax. Their situation will look like this:
Because they own a home and have enough individual deductions to justify itemizing, they reduce the taxes they owe by $2,025, or about $170 per month. This is the tax advantage of owning their home: the difference between what they would pay as a renter (standard deduction) and what they’ll pay as a homeowner (itemized deductions).
On January 1, 2018, the new tax code will presumably take effect. While it is a massive bill (1,097 pages), written by a bunch of lawyers, here are the main changes as they will affect you. We’ll also list some items that will not change even though either the House or Senate version may have originally made a change. These items are from the text of the Tax Reform and Jobs Act itself.
You can deduct interest on the first $1 million of loan.
|You can deduct interest on the first $750,000 of loan|
You can deduct interest on up to $100,000 of loan placed on the property after its purchase, such as a HELOC
|You can no longer deduct interest on a HELOC|
|Property and state income tax
You can deduct the amount of property tax and state income tax you paid
|You can deduct up to $10,000 for the total of property tax and state income tax|
|Capital gains on selling your home
You can exclude up to $500,000 in gain ($250,000 for a single person) as long as you have occupied the home for 2 out of the previous 5 years
|No change. There was a proposal to change the requirement to 5 of the previous 8 years, but it was removed from the final bill|
|Mortgage Credit Certificates (MCC)
These allow first-time buyers of low and moderate income to claim a tax credit for 20% of the interest they pay for as long as they occupy the home as their personal residence
|No change. The House version eliminated MCC, but that provision was removed in the final bill|
Non-Real Estate Provisions
$4,150 per person
|Repealed—no more personal exemption at all|
$13,000 (married filing jointly)
|$24,000 (married filing jointly)
Deductible, but recipient claims it as income
|No longer deductible. Recipient no longer claims it as income.|
Tax applied to estates valued above $5.49 million ($11 million for married decedents)
|Exclusion raised to $11.2 million for single decedent|
|Pass-through Income (corporations and LLCs)
No provision for any adjustments
|20% reduction of pass-through income claimed, but with some limitations and conditions. Essentially, someone who owns a corporation whose income is reported on their personal tax return, that income will be treated at a lower rate than ordinary income. High earners, such as high-producing real estate agents and other professionals, will save a great deal of money with this provision|
|ACA insurance mandate
Those who do not have health insurance will pay a fine, which was deemed by the Supreme Court to be a form of tax
|The ACA mandate is repealed effective 2019|
Seven brackets, ranging from 10%-39.6%.
A taxpayer reaches the top bracket with taxable income of $480,051
|Seven brackets, ranging from 10% to 37%.
A taxpayer reaches the top 37% bracket with $600,000 taxable income. Someone earning $480,051 would see their tax bracket drop to 35% compared to the existing law
How the changes affect you:
The three-person household we have used for our example would see their taxes change like this:
If they don’t itemize their deductions, they’ll see their taxes go down because of the lower marginal tax bracket and the doubled child credit. The credit is temporary: it expires in 2025.
If the family can itemize their deductions the picture looks like this:
The total deductions the family can itemize under the new system amount to $2,500 more than the standard deduction. We have listed that as “additional” on the grid. They will reduce their tax liability by $766, compared to the $2,491 they would save if they were unable to itemize their deductions.
Where to go from here
If you want to examine different scenarios for yourself, do this:
- Print out the old and new tax tables from this page
- Write down your gross income for “old” and “new” scenarios
- Calculate your “old” taxes using either itemized deductions or the standard deduction as appropriate
- Calculate the “new” taxes in the same way
If you are handy with a spreadsheet, you’ll save a great deal of time, at least with the simple math part.
I’ll reiterate: I am not a CPA, tax preparer or tax attorney. I do my best to be accurate, but you should not consider any of what you have just read to be tax advice. You should get that from a licensed professional, not Some Guy on the Internet (me).
You are welcome to reach out to me, however. My direct line is 925-383-2846. If I am unable to pick up, please leave a message.